How does a startup founder add more power to propel faster growth than competing enterprises?
One source that may surprise you is to build a smart revenue model.
It will open your mind to see opportunities to add fresh sources of revenue, move strategic focus to uncontested markets and alter tactics for execution of operations.
Serial entrepreneurs have learned to employ smart revenue models with great effectiveness. Today I have some tips to share with you from their schools of hard knocks.
Let’s start with some basics and begin to drill down to what is important to investors (and experienced startup employees).
- Financial forecasts are valuable. You may have heard that venture investors ignore forecasts of financial statements of startups. My experience is that VCs expect you to know all the details about a financial forecast of our new enterprise, starting with revenue and how it is derived. Investors are more interested in what is behind the numbers than the numbers themselves. For instance, what is the average selling price of your first product, and how will it change over time (supersedes $ of Revenue in importance).
- Power rises from information generated by the components of the revenue forecast and their sub-components. I’ve seen VCs stall a founder’s presentation by peppering her with a barrage of questions about the revenue components. What composes the mix of products/services that determine your average selling price? How is each product of the family (product lines) priced and why? If you are unable to respond instantly, the questioning becomes unmerciful and often terminates the unfinished presentation.
- Modifications over multiple years of time reflect an unfolding story about competitive behavior. What sequence of sub-products will be introduced over the first years and why? How do you expect the competition to react to those introductions (e.g. price discount war, or copying the products)? How will your startup react to their reaction? Serial entrepreneurs have learned the best story tellers get the money. So learn to tell your story with color using your financial forecast over years of growth.
Now let’s turn to some modeling tips and see how to boost power beginning with a simple forecast of revenue and expand it from there.
Model Building Tips
- Use an Excel spreadsheet to build your revenue model. Obvious.
- Use one sheet for the Revenue model. It will feed your Income Statement on a different sheet.
- Start with revenue by year in columns. Begin with 5 years. Start revenue the first year of launch, hopefully not later than Year 2 (life science excepted).
- Use rows for input and output. Units are input.Price per unit is input. Price times units equals Revenue as output. Simple.
- Never put formulas into cells. If your price per unit is to decline each year by X%, then use a separate row for X. Then it is easy to make changes to X and begin sensitivity analysis to learn more about your business. “What happens if the price declines by 10% per year? What will happen if we hit a price war that crushes prices by 40% or more?” Show all inputs separately, each in one row.
- Color inputs with one loud color. It keeps you from going crazy as your model grows in complexity (it will).
Revenue Model Tips
- Forecast $ of Revenue using one simple set of units times one ASP (Average Selling Price) for 5 years. Guess if you have to.
- Return and divide units into specific products/services and add an ASP for each. Average now has more meaning. The model reveals more about product plans each year over the march to IPO. This will cause you to pause and develop a product marketing plan.
- If you are relying on advertising revenue, you must now break up Customers into segments. Use frequency of users to get started. What percentage will be most frequent users? That will be important to advertisers. How many clicks will be done daily, weekly, monthly by Frequent Users, how much by Other Users? I think you can see how this is modeled. One byproduct will be your list of visitors and the click rates and volumes each month. You will certainly be asked about that by VCs anytime during your presentation.
- Now add a mix of advertisers. For instance, you will need to know how much the automobile ads pay per click compared with beauty products or mortgage refinancers. You’ll need to forecast the mix of those classes of customers (who send you cash) so your ASP per click has meaning. This will get your brain working overtime.
- Now you can see a mini revenue model for each of your products. This will reveal which products are generating the most revenue and trigger thoughts about what to modify with marketing in the face of competition in order to gain market share. Each product needs its own market segment forecast (Total Available Market, Served Available Market and Share of Market: TAM, SAM, SOM).
- Return and alter the ASPs over time. They typically decline but some may be expected to increase (e.g. if you began with a deeply discounted initial price to do a Beta Launch). This gets you thinking about the traditional pricing behavior in your industry (e.g. semiconductors rapidly reduce in price per year) and in your new market (e.g. advertising paid per click jumps up and down depending on the advertising market [cars pay more than lipstick]).
- Now you have a lot more information and are growing smarter and more competitive. You know how your business economics respond to small shifts in each input. You are already smarter than the VCs and sharp potential employees. And you are most likely smarter than your competitors who are too lazy or arrogant or naïve to go to all this hard, time-consuming work.
- Let’s dive deeper and build more smart power.
- Return and add seasonality to the first two years of products launched. You will need to create a 24 month model by year. That’s easy. Do not do a quarterly forecast because tht will slow down your work, become very messy, and besides, people want the monthly numbers anyway, especially investors.
- Then add seasonality. Consider the effects on your business of big holidays and four seasons of weather. How will the monthly forecasts be modified: units sold, ASP (pre and post holiday)? This is especially important for ecommerce web businesses selling consumers retail products. This is often a head-snapper for fast thinking entrepreneurs doing their first startup.
- By now you have a ton of insight to your business. You are getting very smart. So is your model.
- Return and divide into countries of the world. Asia is too big for one forecast group. Use Japan, China and so on. Europe might be singular. Other regions can be collections of countries (e.g. South America, Africa). North America can work (Canada plus U.S.).
- Now you can see how much thinking you are going to be doing. Country forecasts reveal where you’ll need to be doing business each year and what you’ll need for employees there. It also will have deep implications for how you incorporate your startup. If you are going to get a lot of revenue from a lot of big countries, then you should consider incorporating the parent organization outside the United States (e.g. Cayman Ilands) and operating subsidiaries in each country (e.g. U.S., England, Japan). It will also get you thinking about time, for instance, it takes many months to plan and complete the construction of a corporation to do business from within China.
Some Game and Social Networking Smart Model Tips
- Game and SNW startups have a lot of revenue complexity from the get-go because they are so creative. Some sell virtual goods paid for by cash. Others sell virtual goods payable by points earned. Affinity clubs earn points exchangeable for points that are exchangeable or for other virtual goods that are exchangeable. See how complex things are getting? All of it impacts $Revenue for the startup. How such things are linked to real Revenue recorded by accountants is important, it is central to your learning by building a smart revenue model. The more you dive into the details, the more you will be driven to address complex issues that can either hinder or improve your competitiveness and revenue generation abilities.
- What drives gamers and SNWers to your business so your Revenue rises? “We’ll go viral!” does not cut it anymore. There is too much competition out there already. You have to have a game plan that is creative and clever, attractive and compelling to end users so you generate the traffic (mix, demographics, volume) sought by advertisers. As mentioned above, the more you can drill down with an advertising model, the more you will learn about your business.
- Games come and go like movies. Start forecasting the rate of rise and fall for each game over time. This will trigger ideas about comparable games by competitors that you can use as benchmarks. Then you can do some sensitivity analysis: Should we plan on a few large winners or a mix of good but not great games to go IPO? How many medium successes do you need? What happens if you have one large winner?
I have seen great serial entrepreneurs present to VCs without showing a single number. But when asked all the questions related to a revenue forecast, they had the numbers ready to verbalize. They were that familiar with their financial forecasts, particularly the Revenue forecast. I was always amazed by their fluency and fluidity with the numbers. As for me, I need to see the model on the screen to explain it. But they got their money. They did their (hard) homework. It’s one aspect of how they became serial entrepreneurs. VCs open doors for them, seek them out, every day.
BOTTOM LINE: You add huge power to your startup when you build a smart revenue model. As you add to it, you think about deeper and deeper details. Your story begins to become colorful. It adds knowledge that directs strategy and tactics. It guides incorporation and tax planning. Most of all, it gives you intimate understanding of how your startup will behave. Like a parent who understands her child intimately, you will be able to anticipate how your enterprise will behave when it is birthed and grows. Yes, it takes time and work (both four letter words). But the investment will be worth it. Serial entrepreneurs know its impact. When you can build a smart revenue model, you will be well ahead of your competition. It will be a key element in the power of your unfair advantage.
I wish you The Best on your Adventure!